Grantor Retained Annuity Trusts

In “Trust Spotlight”, we pick a trust and simplify it to help you better understand how it works. This issue’s spotlight covers the Grantor Retained Annuity Trust, or GRAT.

Missouri Estate Planning, 3rd Ed., Vol. 2, §13.20 states in part, that “the purpose of a GRAT is to transfer future growth in the value of trust assets to family members . . . free from the imposition of federal transfer taxes.”

A GRAT is an irrevocable trust that is typically created for a term of 2 to 4 years. In essence, you transfer volatile assets into a GRAT with the hope that the assets appreciate significantly in that 2 to 4 year period.

During the term of the GRAT, the assets are returned to you via annuity payments based upon the time period selected when you executed the trust. The idea is that you will receive everything back you contributed—including interest!

The goal is to beat the interest rate, which is set by the IRS when the GRAT is created. Highly volatile assets will hopefully appreciate more than the amount of the required annuity payments made out of the GRAT.

The interest rate set by the IRS is known as the “hurdle rate”. If the assets left in the GRAT beat the hurdle rate, you have effectively transferred assets to your beneficiaries free of estate taxes. If not, you will have received your assets back in the form of the annuity and interest payments.

Luckily, interest rates are presently very low, so GRATs today carry with them very little risk, but a lot of reward.

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